Investing in India requires mastering chaos

by Hansi Mehrotra

15th February 2016

Having a young population is great for India’s consumption story and therefore, economic growth, but it may not be so good for its stock markets. The very impatience that leads the youth to start-ups is damaging when investing, according to Saurabh Mukherjea, CEO of institutional equities at Ambit Capital, and author of Gurus of Chaos.

Talking about why he wrote a book highlighting the trials and tribulations of the investment journeys of some of India’s top fund managers, Mukherjea explained that he had interviewed a lot of youngsters while building his team and was disappointed to note that the ‘for the vast majority of those people, the stock market was bit of a casino, bit of a lottery, which is a deeply damaging mindset for them. It suggests that they are coming to the market to look for a quick way to get rich i.e. they are looking for short cuts; they don’t want to invest the time to learn and grow. It’s damaging for them, it’s damaging for potential employers and it’s damaging to the market as a whole because it gets populated by the wrong sort of people. It’s also damaging to the country as a whole because if people are driven just by greed, the outcomes the market produces are seldom worthwhile for the ordinary citizens saving for the retirement.’

Mukherjea believes that the young need to understand that the successful investors didn’t just get there without putting in the hard work. By highlighting their learning process, he hopes to show them that ‘If you want to be like Sankaran Naren, you need to put the time in. None of these people got to where they go to by just turning up with a fancy degree.’

 

Indian discount rates are high

Mukherjea is an alumnus of the London School of Economics and worked for ten years in the UK before moving to India in 2008. Having seen both the UK and Indian funds management markets, his observation is that ‘everyone’s discount rate is very high in India, whether it’s for crossing the road, whether it’s for building a business, or whether for investing in the market.’ Since a high discount rates implies that people value the future less, he believes that the main feature of the Indian market is that Indians tend to be more impatient. ‘We are a younger country; everyone wants to get rich quickly. In some spheres, it’s not a bad thing…but in our line of work, impatience is deadly and is hard-wired into Indian mentality and therefore, into the Indian economy and markets,’ he said.

Turning to the quality of talent in the professional funds management industry, Mukherjea is upbeat, saying he believes that the quality of talent at the CIO level is comparable to anywhere in the world. However, he sees a bottleneck in the lower rungs – the analyst or junior fund manager who has just finished their CFA or MBA and spent 3-5 years in the market. He says that in India, there aren’t that many structured training or mentoring mechanisms. So the 25-35 year age is a challenge for the domestic buy side and sell side. ‘Right now, it’s up to the person to develop himself rather than relying upon professional or industry support,’ he said.

Mutual funds have tough job

Mukherjea’s job as a sell side analyst is to provide research ideas to the buy side i.e. the domestic mutual funds as well as foreign institutional investors. His vantage point allows him to compare the two – and he believes that local funds have a tough job because of pressure to perform on a daily basis.

‘The main challenge for the domestic fund manager is the NAV pressure. Usually, you can outperform the benchmark reasonably comfortably, if you take a long-term view. But they have to outperform a benchmark daily, which is impossible.’ Mukherjea believes that the pressure doesn’t come so much from their employers as it does from the distributor community. In contrast, he points out that FIIs have a more relaxed investment horizon on a comparative basis although they also have to perform over 1 and 3 years. In his view, the only type of funds that can do well is the ‘unconstrained permanent capital’ such as family offices, or sovereign wealth funds.

By Mukherjea’s estimates, the DIIs have done well in rupee terms but not so well in US terms. Even the large cap funds tend to take a tilt towards small cap, which a typical global emerging market fund can’t do because of the MSCI benchmark. If one adjusts for the rupee and liquidity, he believes the best performer would have been the unconstrained FIIs. But he’s quick to point out that he doesn’t see skill as the big driver here; it’s the constraints.

 

 

Style in the Indian market

Mukherjea believes there are serious issues in accounting and corporate governance in India. Hence, quality works and value doesn’t. He said, ‘If you were to systematically buy value, traditionally defined as low Price to Book, you would buy trash. You could continuously do that and just about beat the index.’ On the other hand, if investors are conscious about quality and screening on ROE/ROCE filter or other qualitative filters, they are unlikely to find cheap stocks. ‘A quality portfolio does give you outperformance. But a valuation overlay over and above a quality screen is not likely to generate a good return. India is an inefficient market, with serious accounting and governance issues. The only protection is to be conscious of these but then don’t punish yourself by becoming value conscious. You’ll get caught in between.’

Mukherjea believes there are style differences in the Indian market, but they are not as simple as value or growth. ‘If you look at the fund managers covered in Gurus of Chaos, there are differences in style. For example S Naren is very different to the anonymous investor profiled in the book. Naren is essentially value focused; when the market gets overvalued, he starts reducing his position. Whereas the anonymous investor says it’s not his job to make market calls. So if he doesn’t fund stocks he might desist from buying but will not start dumping either. Both approaches are valid. Provided if you as the investor understand the style differences, these approaches are valid.’

However, investors can’t define the AMC by style; they have to pay attention to the actual individual fund manager. ‘AMCs see themselves as a multi-cuisine restaurant so they will have a fund of every style to cater to all tastes. The AMC says I am style agnostic,’ Mukherjea said. ‘Most AMCs have one or two large flagship funds, which they lavish attention on and assign to star fund managers to. They will market these well so the flows are strong which they can use to support their positions. But they will also have a tail of smaller funds, so you will see a dispersion of returns amongst the funds.’

Mukherjea cautions investors against trying to time funds – ‘If market timing is hard to pull off by even the best of fund managers, timing of funds is even harder. There is no point killing yourself in trying to do that.’ His recommendation is to choose 2-3 high quality small cap funds, 2-3 large cap and 2-3 bond funds and spread one third in each. There is enough choice to build a good quality portfolio from this. Avoid real estate.’ He promised to elaborate on his views on real estate another time.